The Personal Savings Allowance: what you need to know

From 6 April 2016, a new Personal Savings Allowance (PSA) will be introduced, which will take around 95% of taxpayers out of paying any tax at all on their savings income, such as interest.

The PSA was first announced in the 2015 Budget and means that savings earned in banks, building societies, NS&I products, company bonds and credit unions won’t be taxed up to a certain amount. But the rules vary depending on whether you’re a basic, higher or additional rate taxpayer.

This is an important new rule yet research from AA Financial Services found that a staggering 90% of savers don’t know what the allowance is and are struggling to determine where to put their savings after April.

The Q&A below explains what you need to know about the new allowance:

What is the Personal Savings Allowance?

The PSA is a government measure aimed at reducing the amount of tax people pay on their savings income. It comes into effect from 6 April 2016.

Basic rate taxpayers (20%) who earn up to £42,385 (or £43,000 from April) will be able to earn up to £1,000 of savings income without any tax being due. Higher rate taxpayers (40%) who earn up to £150,000 will get a £500 PSA. But additional rate taxpayers (45%) who earn above £150,000 are not eligible for a PSA.

How will it work?

Currently, banks and building societies deduct income tax from interest earned on products and accounts – apart from ISAs – at a flat rate of 20%, the basic rate of income tax.

For higher earners, the additional 20% is either collected through their PAYE code which tells the employer how much tax should be applied to their salary, or they have to submit a tax return.

For additional rate taxpayers, they usually need to inform HMRC how much savings income they’ve earned through a self-assessment (tax return) where they’ll pay the extra 25%.

However, from 6 April, banks and building societies will no longer deduct the flat rate 20% income tax from interest earned. Instead, providers will need to report savings information to HM Revenue & Customs (HMRC).

The new system is a move towards more reliance on PAYE codes and HMRC says, where possible, it will work out a person’s tax code based on how much savings income they have earned in previous years. HMRC says it has already adjusted codes for some customers, such as higher rate taxpayers, who previously paid tax on savings and who it estimates will have no tax to pay on savings income because of the PSA.

For others, HMRC will need to wait for information from banks and other providers in order to adjust PAYE codes, though it couldn’t say when in the tax year codes would be adjusted. It depends on “when it receives information from the provider”.

HMRC says it will write separately to individuals who have their code changed to explain the move, and to tell them what to do if they disagree. It says customers with savings accounts should be receiving letters from their banks and building societies detailing the changes.

If you’re not employed but you generate a savings income, you’ll need to submit a tax return to HMRC.

What if I go over my PSA?

If you exceed your PSA, your PAYE tax code will be adjusted and HMRC will deduct any tax owed from your take home pay.

HMRC says, “where possible”, it will collect the tax owed in the same year by changing the tax code once it receives information from banks and building societies. Customers can also contact HMRC to tell them they have exceeded their PSA at any time. If you have difficulty paying any tax owed, HMRC says people “can talk to us” to discuss collecting tax over multiple years.

Will the PSA affect the new £5,000 Dividend Allowance or my existing ISA?

No, these are two separate allowances and ISAs are tax-free.

What happens if I have a joint account?

You’ll both receive a PSA. If you’re a basic rate taxpayer and your partner’s a higher rate taxpayer, you’ll receive a PSA of £1,000 and £500 respectively.

What happens if I have multiple accounts?

HMRC says it will cross reference all the information it receives from each of the banks with taxpayer information and, “where possible”, collect the tax automatically through the individual’s tax code, something which it has been doing for years.

Do monthly reward/cashback schemes count towards the PSA?

The PSA covers savings income, which includes interest, but not all payments made by banks and building societies are considered ‘savings income’. If you receive a monthly reward such as the Halifax’s £5 per month or a bonus for switching current accounts, these are considered ‘annual payments’ and are not covered by the PSA. HMRC says this means the payments are subject to tax. If you’re a non taxpayer, you can claim the amount back using a R40 form (or form R43 if living overseas) and sending it to HMRC.

What about interest paid on PPI and other compensation payments?

Banks and building societies will still be required to take tax from any compensation interest paid -it’s not considered as part of your PSA. But you may be able to claim the tax back by filling in form R40 (or form R43 if living overseas), as above.

Do I need to tell account providers about other savings income?

No, you don’t need to give any information about your tax circumstances or other savings income to your account provider.